In a move that could have dramatic consequences for the financial stability of Bank of America (BofA), a New York state court judge has held that monoline bond insurer MBIA can go forward with claims that BofA be held vicariously liable for claims against its subsidiary, Countrywide.  BofA has already filed an appeal of the Order, issued by Judge Eileen Bransten in New York State Supreme Court in the case of MBIA v. Countrywide Home Loans, et al. Bransten held, among other things, that MBIA could proceed with its argument that BofA was vicariously liable for the debts of Countrywide as successor-in-interest, based on a claim of a de facto merger between the companies.

In the case, MBIA alleges that a significant percentage of tens of thousands of home equity lines of credit (HELOCs) and second-lien loans issued by Countrywide entities in various securitizations insured by MBIA failed to comply with Countrywide’s underwriting guidelines or other reps and warranties.  Bransten’s Order Granting in Part and Denying in Part Defendants’ Motion to Dismiss, issued on April 27, 2010, denied Countrywide and BofA’s motion to dismiss as to MBIA’s claims for fraud, breach of the implied covenant (though this claim was narrowed) and successor and vicarious liability against BofA, while granting the motion to dismiss as to MBIA’s claim for negligent misrepresentation.

The transcript of the oral argument surrounding this motion makes for particularly entertaining reading (at least for mortgage litigation nerds, such as myself).  In that hearing, David Apfel, counsel for BofA and Countrywide, argued that the successor liability claim was “frivolous,” and that MBIA should not be allowed even to pursue discovery regarding the issue.  Judge Bransten did not buy these arguments, denying BofA’s motion to dismiss as to the successor liability claim and ordering discovery to move forward.  Bransten also expressed significant dissatisfaction with the pace of the production of documents from BofA and Countrywide.  In response to Apfel’s statement that, “Countywide ha[s] been working hard [at discovery],” the Judge responded, “It’s not going well enough… Get discovery, documentary discovery done.”

This ruling came on the heels of another adverse ruling for Countrywide emanating from Bransten’s pen.  In a related case styled Syncora Guarantee, Inc. v. Countrywide Home Loans, Inc., et al., Bransten ordered Countrywide to begin producing loan files underlying the delinquent loans in three securitizations insured by bond insurer, Syncora.  The Syncora case (along with MBIA v. Countrywide and FGIC v. Countrywide) is one of three related bond insurance cases involving BofA and Countrywide before Judge Bransten (note: bond insurers provide insurance on an entire securitization, or pool of loans, rather than on individual loans).  The acquisition of loan files, and servicers’ reluctance to turn over the same, is a critical issue for investors pursuing claims against originators and servicers for irresponsible lending practices in connection with the loans underlying the mortgage-backed securities they purchased.

Bill Frey, whose broker-dealer, Greenwich Financial Services, is the plaintiff in a lawsuit against Countrywide in New York state court, has been closely following the bond insurance litigation against Countrywide and BofA in New York.  He commented on Judge Bransten’s recent rulings that, “it sounds like [Judge Bransten] understands that you need to honor commitments and contracts if you are going to have an economy work.”  Frey’s suit, which seeks to force Countrywide to pay for the loan modifications it has agreed to perform in a settlement with the Attorney Generals from more than 30 states, awaits a ruling on Countrywide’s motion to dismiss.

Yet, while those with claims against Countrywide are watching this litigation closely, most of the mainstream media has been slow to recognize the significance of these decisions.  Certainly, if BofA is on the hook for the massive potential liabilities of Countrywide stemming from its years of volume lending, this could undermine Bank of America’s solvency, which, in turn, could have a dramatic ripple effect on the other major banks and the financial system as a whole.  BofA will have to take a stand, and whether or not this litigation is where BofA’s ultimate liability is determined, contesting Bransten’s vicarious liability ruling will be an important first battle.

Andrew Longstreth gets it.  In an April 29, 2010 article for AmLaw Litigation (subscription required), Longstreth notes that this is the first time a judge has allowed claims to proceed against BofA for the liabilities of Countrywide.  Longstreth quotes MBIA’s attorney, Phillip Selendy, as saying, “[the decision] is going to have an impact beyond this case.”  That could be the understatement of the year.

BofA/Countrywide filed the Notice of Appeal (available here) on May 28, 2010, indicating that it would be challenging the adverse portions of the April 27 ruling before the Appellate Division of the Supreme Court of the State of New York, in and for the First Division.  BofA/Countrywide also filed a Pre-Argument Statement (available here) before the Appellate Court, in which it argued that Judge Bransten improperly applied New York law, rather than Delaware law, to determine the issue of successor liability, and that MBIA failed to allege, as required, that the merger between the companies “was engineered to disadvantage Countrywide’s shareholders or creditors.”  BofA/Countrywide further decried the fact that, since Bransten’s decision on vicarious liability, both FGIC and Syncora have amended their complaints against Countrywide to add BofA as a defendant.

This may be one of the primary reasons that BofA has chosen to pursue the risky strategy of appealing Bransten’s Order.  Though the ruling does not definitively hold that BofA and Countrywide entered into a de facto merger–it simply allows such a claim to move forward–BofA faces the prospect of other litigants being emboldened to bring claims against BofA wherever they have claims against Countrywide.  Though BofA runs the risk that, by appealing, it could suffer an adverse ruling at the hands of the Appellate Division of New York Supreme Court–a ruling that would have broader precedential value than Bransten’s Order–BofA has presumably decided to take an early stand in the hopes of cutting off the flood of litigation before it begins.

Yet, it is unclear whether BofA has as strong a case as it thinks.  The de facto merger exception to the general rule that an acquirer does not become responsible for the liabilities of the acquired corporation turns on whether the acquirer absorbs and continues the prior operations of the acquired corporation or dissolves the company’s management and general business operations.  MBIA has alleged facts showing that BofA retired the Countrywide brand, including its website, and cites favorable New York case law holding that all-stock acquisitions, such as BofA’s acquisition of Countrywide, suggest that a de facto merger has occurred.  MBIA also cites BofA’s pursuit of a settlement of predatory lending suits with state Attorneys General immediately following its acquisition as evidence of the cessation and dissolution of Countrywide’s business.

BofA’s primary argument on appeal appears to be that Bransten erred in applying New York law to the vicarious liability claim.  The bank argues that Bransten should have instead applied Delaware law, which is more favorable to acquirers wishing to avoid successor liability.  But the argument has the distinct feel of a Hail Mary, as it did not appear to be a focus in BofA’s briefs, and Apfel did not even raise it during oral argument on the motion.

In fact, Apfel repeatedly exhorted Judge Bransten to read an order from Judge Mariana Pfaelzer the Central District of California from the case Argent v. Countrywide, which Apfel described as featuring “the exact same facts” as MBIA. Bransten actually excoriated Apfel at one point to direct her towards a New York case, saying “please, please, there must be a New York case that we can rely on.  At least, give me some guidance” (see transcript at 41-42).  Apfel responded, simply, “[o]kay.”  Id. At no point did BofA’s counsel argue that Delaware law should actually apply.

Instead, Bransten appeared to become quite irritated at Apfel’s repeated entreaties for her to read Argent–again, a California case.  At one point, after Bransten asked Apfel to move on to his next argument and Apfel again asked Bransten to read Argent, Bransten responded, “as I stated before, I’m going to read it, all right.  I mean, you don’t have to remind me to read it… It’s only been the tenth time asking me to read it” (see transcript at 41-42).

Meanwhile, the MBIA litigation moves forward, and MBIA has filed a Motion to Compel, to force Countrywide to produce 1) delinquent loan files, 2) documents Defendants previously produced to various state Attorneys General in connection with their settlement with Countrywide, and 3) documents relating to BofA’s successor liability.  The Reply brief, filed June 8, is available here.  BofA and Countrywide will certainly fight hard to avoid turning over these critical documents.  But, judging by Judge Bransten’s recent opinions, and her palpable frustration with BofA’s discovery conduct, I don’t like the bank’s chances of avoiding this production.